Turkish President Recep Tayyip Erdogan suffered a blow in local weekend elections, setting the stage for more near-term uncertainty for investors, according to ABN Amro.
Erdogan’s People’s Alliance, comprising the AKP (Justice and Development Party) and MHP, (Nationalist Movement Party), lost control of Ankara, Istanbul and Izmir — Turkey’s three largest cities in terms of population and economic clout.
“While the local elections have no effect on the leadership at a national level, the People Alliance losing the control over the big cities constitutes a clear warning signal that people are not satisfied with the current economic policy of the regime,” wrote Nora Neuteboom, emerging-markets economist, and Georgette Boele, senior currency strategist at ABN AMRO.
“Last month, [Treasury and Finance] Minister [Berat] Albayrak…announced that Turkey will embark on a round of reforms after the elections, and presented a roadmap for the coming years. Given the results of the election, however, we think momentum behind structural reforms is likely to fall somewhat,” they said.
Turkey is highly dependent on foreign investors to fund its burgeoning current-account deficit, most of which is dollar-denominated, which can leave it at the mercy of market gyrations. The current-account deficit, is a measure of a nation’s debt to other countries.
A failure to bring about structural reforms likely won’t appease investors and is likely to stoke further consternation about the integrity of financial markets. During last year’s emerging-market selloff, Turkey — alongside Argentina — was hit hard.
Emerging-market economies which hold dollar-denominated debt, like Turkey, can face difficulties servicing that debt in local currency terms when the dollar strengthens.
Given last year’s drama and its double-digit inflation, financial problems in Turkey have been watched as a gauge of the buck’s strength and its potentially deleterious effect on emerging markets, even if many of Ankara’s economic woes are considered idiosyncratic.
Read: Turkey’s technical recession underlines the dilemma facing the country’s central bank
Ahead of Turkey’s weekend elections, the Central Bank of the Republic of Turkey, intervened in financial markets, in an effort to calm financial turmoil, particularly in the lira’s USDTRY, +0.5359% exchange rate.
Don’t miss: Turkey’s lira is tumbling amid renewed fears of an emerging-market selloff
As the lira was weakening, the government last Wednesday stepped in to prevent offshore bets against its currency by restricting lira borrowing. Many investors in the lira complained that they were unable to unwind swap transactions, with the overnight swap rate, reflecting the short-term currency borrowing rate, jumping to a high of 1,350%, Neuteboom and Boele wrote, from a level of 23% a day before.
The CBRT, meanwhile, suspended its one-week repo auctions “which basically means that banks can lend at the CBRT for the overnight lending and the late liquidity window which stand at 25.5% and 27%,” Neuteboom and Boele said, a move which represents monetary tightening, because the one-week repo rate last stood at 24%.
All this weighed on Turkish stocks, such as its BIST 100 benchmark XU100, +0.34% Exchange trade funds that reflect Turkish stock-market, the iShares MSCI Turkey ETF TUR, +2.22% and local-currency bonds. Market participants said the sudden drying up of liquidity in Turkey’s financial market could scare investors in the future, which also could exacerbate its current problems.
There is also more potential for diplomatic conflict between Ankara and Washington, as Turkey was negotiated with Russia to purchase a missile-defense system, an act that has drawn a rebuke from the U.S. On Monday, the U.S. suspended the delivery of military equipment to Turkey in response to its recent talks with Russia, according to a Reuters report.
“These Turkey-specific factors come against the backdrop of cooling global economic growth, affecting general risk sentiment. We think investors will shy away from Turkey going forward, resulting in a weaker lira against the dollar,” said Neuteboom and Boele.
One dollar last bought 5.4823 lira, down 1.7%.
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